Financing India’s Small Hydro Capacity

Issue 4 and Volume 16.

David Appleyard7.15.13

LONDON — India’s scope for hydropower development is vast. Close to 150 GW of theoretical potential exists in the country today, with an estimated 84 GW of economically exploitable capacity, according to figures from the Central Electricity Authority (CEA). Simultaneously, there is a large population of rural poor with no access to grid electricity, an existing peak load deficit estimate at around 10 percent and a rapidly growing economy — and with it an associated increase in power demand.

Indeed, India’s economy reportedly grew at its slowest pace in a decade during the 2012-2013 financial year, but still clocked up a 5 percent growth rate over the year. Prime Minister Manmohan Singh reportedly expressed confidence that the country’s economy would bounce back to an “8 percent growth rate.”

CEA projects electricity demand to increase by around 40 percent by 2016-2017 and just about double by 2021-2022.

However, there are a number of structural issues that impact on the country’s ability to develop large capital-intensive projects like large-scale hydropower and as a result a good deal of attention has been focused on the development of small hydropower capacity, deemed projects with a nameplate output of 25 MW or less.

Authorities report that there is significant potential for hydropower development on this scale. Figures from the responsible agency, the Ministry of New and Renewable Energy (MNRE), estimate the potential for power generation in the country from such plants at over 15 GW.

Recognizing that small hydropower projects can play a critical role in improving the overall energy scenario of the country and in particular for remote and inaccessible areas, the Ministry aims to harness at least half of the potential in the country over the next decade to bring the installed capacity of small hydro to about 7 GW by the end of 12th Plan in 2017. In August 2012, the Minister of New and Renewable Energy, Dr. Farooq Abdullah, said that during the 11th Plan, a capacity of 1,419 MW of small hydro was added compared to 536 MW during the 10th Plan.

Some 967 small hydro projects with an aggregate capacity of 3,632 MW have been installed in India to the end of April 2013, with 24 states announcing a policy to invite private sector bodies to set up projects. In addition, 281 small hydro projects with an aggregate capacity of 1,061 MW are also under construction in various states.

MNRE said it is providing Central Financial Assistance to set up small/micro hydro projects both in the public and private sectors while financial support is also given to the state governments for the identification of new potential sites, including surveys and the preparation of detailed project reports, and renovation and modernization of old projects. In 2012-2013 some Rs.1.6 billion [US $28 million] of funding was released under the Small Hydro Power (SHP) Program.

Driving Private Investment

Given the vast potential and obvious drivers for demand, why has India been so hesitant when it comes to execution? While some would point to the strength of country’s coal lobby, a more pertinent point is the key to all energy development: economics.

Shedding light on this theme, the recent HydroVision India Conference and Exhibition heard from Anchit Gupta, director of business development at Focal Energy, a global investment group specializing in small hydro and solar installations with more than 300 MW of projects in its pipeline. Gupta said the company is primarily looking at a steady cash flow from income generating assets.

When considering investing in a hydropower development, Gupta explained that a good partner with honesty and integrity is the most important element, together with projections and adequate contingencies within the project plan.

However, the cost of debt and the interest rate on capital is a major influence, and Gupta said that even though the company is an equity investor, it maintains focus on capital rates rather than equity returns. This, he says, is the most pressing issue for renewable energy and infrastructure development in India.

“With a larger operating portfolio we can go out and get much cheaper debt, but until then the focus is on projects which are profitable with adequate cash flow, considering the risks involved,” he explained.

He presented a typical example of a project deal with a debt-to-equity ratio of 70:30, a typical interest rate of 14 percent and a repayment period of eight years. In this case “around 22 percent of total project cost in the first year is outflow to service debt. Most projects are not generating that kind of cash flow in the first few years,” he said. “That is one of the most pressing issues for renewable energy in India.”

He added that a realistic assessment of revenue is critical. “One of the challenges [is that] projects are more often than not over-advertised with under-estimation of revenue project costs and over-estimations of energy production potential. We have a benchmark for a 30 percent haircut and so far we been spot on. You could say that Indian developers are consistently inconsistent in over-estimating generation potential.”

Valuing Projects

Aside from the cost of debt, Gupta also points out that project valuations can be an issue in the small hydropower sector. “The other challenge we face is the valuation expectations by developers. They expect they’re going to get the same valuations as projects they may hear about in the market,” he said. Focal Energy, he added, “focuses on a very thorough and aggressive due diligence process. For example, developers may say, ‘the tariff is going to be increased in two months’ — well, we can wait for two months and see what happens. Whatever is there and can be supported is what we rely on.”

Giving further insights into the company’s due-diligence process, Gupta explained that they keep an eye on projects that they didn’t invest in “to give us a benchmark for evaluating the opportunity we have come across,” he said. “We also know that there are enough projects available for us to invest in, and if we walk away we don’t sweat it.”

Gupta explained how to create a win-win situation in developing small hydropower. “We do spend a lot of time on the ground in order to fully understand the developer and local issues,” he said, adding that key issues are a strict adherence to budgets and timelines, reliable cash flow and accurate project valuations. He also addressed the changing nature of small hydro developers, saying that there are very good and hard-working entrepreneurs in India who are prepared to stand behind agreements no matter what, but there is a need to overcome the family business approach, accepting that experts can come in and that standards need to change with a different perception of the risks involved, which comes from experience.

“Most [developers] plan so that everything is going to be perfect, but we say ‘not everything will be perfect you need to plan for contingencies,'” Gupta said. “Working with a long-term partner some say, ‘initially it was very hard for us, but now we see the value on this approach.'”

In terms of attracting foreign investment to small hydropower projects in India, Gupta said that a fundamental issue is the regulatory environment that “keeps changing from time to time.” But he also said that there are potentially big gains for companies who can take the risk. “There is a big need for foreign capital looking for credible income generating assets. And there are huge capital needs for infrastructure projects in India; I believe there is the groundwork for creating win-wins.”

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